BDO SEIDMAN, LLPS December 22, 2005 FINANCIAL REPORTING UPDATE

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BDO SEIDMAN, LLPSDecember 22, 2005FINANCIAL
REPORTING UPDATE
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Speakers and Replay Information

• Speakers
• Jeff Lenz
• Jay Howell
• Wendy Hambleton
• Adam Brown
• Reva Steinberg
• Replay Access
• www.bdo.com/about/publications/assurance

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Agenda

• SEC Update
• Internal Control Reporting Update
• SEC Conference Report
• Questions and Answers

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SEC UPDATEDecember 2005
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SEC Update Agenda

• Rulemaking Changes in accelerated filing rules
• Other SEC activities
• Proposed rules
• Interpretive release
• FAQ
• Advisory Committee on Smaller Public Companies

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Changes in Accelerated Filing Rules

• Final rules adopted 12/14/05 release not yet
  posted
• Remarks are subject to reading the release
• Press release at http//www.sec.gov/news/press/200
  5-176.htm
• Changes from Proposed Rules
• Large accelerated filers given one more year to
  file 10-K within 75 days
• Will be easier to change to a less accelerated
  status (this year)
• Accelerated filer becomes a non-accelerated filer
  in same year as Q2 public float drops below 50M
• Since only accelerated filers are required to
  report on internal control, some companies will
  get a reprieve

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Changes in Due Dates
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Exiting an Accelerated Filing Category

• Previous Revenue and public equity float lt 25M
  for two years
• New Large accelerated filer ? accelerated filer
  
• Change status in same year as Q2 float drops
  below 500M
• New Accelerated filer ? non-accelerated filer
• Change status in same year as Q2 float drops
  below 50M
• Tests performed at year-end
• First report in a new category is always an
  annual report

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Exiting an Accelerated Filing Category - Example

• Accelerated filer with a December year-end
• 6/30/06 public equity float drops to 49 million
• Issuer must file its 6/30/06 and 9/30/06 Form
  10-Qs on an accelerated basis (within 40 days)
• Issuer may file its 12/31/06 Form 10-K on a
  non-accelerated basis (within 90 days)
• 404 reporting not required in 2006 Form 10-K
• See Financial Reporting letter at
  www.bdo.com/about/publications/assurance

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Other SEC ActivitiesProposed Rules

• Internet Availability of Proxy Materials (Release
  34-52926)
• http//www.sec.gov/rules/proposed/34-52926.pdf
• Amendments to the Tender Offer Best-Price Rule
  (Release 34-52968)
• http//www.sec.gov/rules/proposed/34-52968.pdf
• Allowing foreign private issuers to exit the
  Exchange Act reporting system (release not yet
  posted)

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Other SEC Activities

• Interpretive release Revenue recognition
  sales of certain vaccines for government
  stockpile programs
• http//www.sec.gov/rules/interp/33-8642.pdf
• FAQ Securities Offering Reform, 11/30/05
• http//www.sec.gov/divisions/corpfin/faqs/securiti
  es_offering_reform_qa.pdf

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Advisory Committee on Smaller Public Companies -
Background

• Established December 2004 to assess regulatory
  system for smaller public companies, including
  the impact of SOX
• Recommendations due to SEC by April 2006
• Four subcommittees
• Accounting Standards
• Corporate Governance and Disclosure
• Capital Formation
• Internal Controls
• http//www.sec.gov/info/smallbus/acspc.shtml

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Advisory Committee Definitions

• Smaller public company
• Aggregate market cap lowest 6 (700-750M)
• AND
• Revenues no greater than 250M
• Microcap company
• Aggregate market cap lowest 1 (100-125M)
• AND
• Revenues no greater than 125M

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Advisory Committee Process

• August 2005 recommendations
• 1-year deferral of internal control reporting
  (non-accelerated filers)
• No further acceleration for smaller public
  companies
• 12/14/05 Approved preliminary formal
  recommendations
• 1/23/06 Approve draft report for public comment
• 3/31/06 Finalize report
• April 2006 Submit recommendations to SEC

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Advisory Committee RecommendationsAccounting
Standards

• Reduce the number of years of financial
  statements required in SEC filings from 3 to 2
• Implement a de minimis provision for auditor
  independence rules
• Permit microcap companies to apply the same
  effective dates as the FASB provides for private
  companies
• Consider additional guidance with respect to
  materiality related to previously issued
  financial statements
• Develop a safe harbor protocol for accounting

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Advisory Committee RecommendationsCorporate
Governance Disclosure

• As a condition to the relief from 404 reporting
  recommended by the 404 subcommittee, require
• Additional disclosure regarding internal controls
  and
• Additional audit committee corporate governance
  standards
• Increase the thresholds requiring registration
  and permitting de-registration
• Allow smaller public companies to use Form S-3
  and eliminate timely filing requirements

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Advisory Committee RecommendationsCapital
Formation

• Adopt a new private offering exemption that does
  not prohibit general solicitation and advertising
  for transactions with certain purchasers
• Make it easier for microcap companies to go
  private

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Advisory Committee RecommendationsInternal
Controls

• Internal control reporting recommendations will
  be covered in the internal control reporting
  update

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Internal Control Reporting Update December
2005
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Section 404 Update Topics

• PCAOB Update
• COSOs draft guidance on internal controls for
  smaller public companies
• Smaller Public Company Advisory Committee
• Recent Section 404 recommendations

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PCAOB Update Report on Initial Implementation
of AS2

• Issued November 30 and located at
• http//www.pcaobus.org/Rules/Docket_014/2005-11-30
  _Release_2005-023.pdf
• Based in significant part on inspections of the
  larger accounting firms
• Focuses on effectiveness and efficiency of audits
  of internal controls
• Provides additional clarifications

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PCAOB Update Report on Initial Implementation
of AS2

• Matters pertaining to efficiency
• Integrating the audit of internal control
• Applying the top-down approach
• Altering the nature, timing and extent of testing
• Performing more effective walkthroughs
• Using the work of others

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PCAOB Update Report on Initial Implementation
of AS2

• Matters pertaining to effectiveness
• Identification and testing of compensating
  controls
• Controls over the financial statement preparation
  process
• Disclosure checklists
• Non-standard, consolidating, and eliminating
  journal entries
• Cash flow and equity statements
• Footnote disclosures

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PCAOB Update Report on Initial Implementation
of AS2

• Additional Clarifications
• More than remote at least reasonably
  possible
• Strong indicators of material weaknesses in AS2
  do not automatically result in a material
  weakness
• Scope of audit should not be set to detect
  deficiencies that individually or in the
  aggregate are less severe than material
  weaknesses
• Tests of control can be used to meet the
  objectives of both the financial audit and the
  internal control audit

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PCAOB Update Recent Personnel Changes

• William J. McDonough - Retired Chairman of the
  Public Company Accounting Oversight Board
• Bill Gradison Acting Chairman
• Douglas Carmichael Outgoing Chief Auditor
• Thomas Ray New Chief Auditor

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COSO Exposure DraftGuidance for Smaller Public
Companies

• Recognition of differences between larger vs.
  smaller entities
• Twenty-six fundamental principles
• Detailed guidance and examples for each principle
• Controls need to be cost effective
• Comments due December 31, 2005

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Advisory Committee Recommendations Pertaining to
Section 404

• 1. Exempt Microcaps from Section 404
• Market cap lowest 1 (100-125M), and
• Revenues no greater than 125M
• 2. Exempt smaller public companies from the audit
  requirements of Section 404
• Market cap lowest 6 (700-750M), and
• Revenues no greater than 250M
• 3. Alternatively to 2, develop a right-sized
  audit approach focused on the design of internal
  controls

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Advisory Committee Recommendations Pertaining to
Section 404

• Complete recommendations located at
• http//www.sec.gov/info/smallbus/acspc/pr-intcontr
  ol.pdf
• BDOs recent comment letter and recommendations
  located at
• http//www.sec.gov/rules/proposed/s70603/bdoseidma
  n103105.pdf

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AICPA SEC Conference Report December 2005
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Conference Themes

• Overall themes of keynote speeches
• Accounting standards are too complex
• Management and auditors should be able to use
  judgment
• Complexity is increased by exceptions in GAAP
• Indirect cash flow method
• Hedge accounting
• Aggregation of segments
• Narrow interpretations of rules

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Conference Themes (cont.)

• Carol Stacey (Chief Accountant in the Division of
  Corporation Finance) Key comments
• MDA area of filings needing most improvement
• Other areas discussed by staff
• Classification in cash flow statements
• Segment issues

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Materiality SAB

• The staff is aware of diversity in practice
  resulting from difference between rollover and
  iron curtain approaches to analyzing proposed
  adjustments
• Believes both methods should be used
• No clear indication from the SEC for timing of
  new guidance
• However, the staff indicated any new guidance
  would not be effective for 2005 calendar
  year-ends
• Transition will be a key issue
• What should registrants do?
• Analyze existing policies to ensure theyre
  consistently understood throughout the company
• Start thinking about SAB 74 disclosures

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Segments Reporting Units

• Proper aggregation of operating segments depends
  on
• Similar economic characteristics, and
• 5 criteria in paragraph 17 of SFAS 131
• Identification of operating segments impacts
  determination of reporting units under SFAS 142
• Affects goodwill impairment analysis
• If material, treatment of reporting units may be
  a critical accounting policy

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Valuation Issues

• Prohibition of block discounts
• The use of quoted market prices is required in
  existing GAAP (SFAS 107 and 115)
• No longer allowed in specialized industries when
  Fair Value standard becomes effective (paragraph
  28 of SFAS 15X)
• Warrants issued to non-employees
• Typically no transfer restrictions and little/no
  vesting period
• When using Black-Scholes, use contractual term,
  not expected term

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Income Statement Geography

• EITF 99-19 was drafted in the context of
  internet-based companies, but its scope applies
  broadly. For example,
• Cable television operator who is responsible
  for vendor taxes?
• Consider all facts and circumstances
• Use consistent application for similar revenue
  streams, similar to adopting an accounting policy
• Amortization of intangibles determined by
  function, as well as SEC rules for public cos.
• Influences Cost of Sales vs. SGA determination
• S-X Rule 5-03
• SAB Topic 11B

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Cash Flow Statement Geography

• Discontinued operations presentation
• Option to present cash flows from discontinued
  operations separately
• If elected, present effect for all 3 categories
• Dealer floor plan financing
• If finance entity is a subsidiary of supplier,
  purchases are reflected as increases to inventory
  and trade loans in operating activities
• If finance entity is not a subsidiary of
  supplier, cash flows to/from 3rd party lender are
  financing activities
• Insurance settlements
• Classification depends on nature of proceeds
• Impacts MDA discussion

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Financial Instrument Issues

• FAS 133 Short cut method
• Redeemable equity securities
• Convertible debt and warrants
• Implicit variable interests

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FAS 133 Short-Cut Method

• Exception to certain requirements for assessing
  and testing hedge effectiveness
• ALL conditions of paragraph 68 must be met
• There is no spirit or principle that can be
  met
• Interest rate swaps with financing elements
• Would not meet shortcut criteria as swap fair
  value would not be equal to zero at inception
• Inappropriate application of the shortcut method
  results in loss of hedge accounting

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Redeemable Equity Securities

• EITF Topic D-98
• Redeemable shares recognized at fair value and
  classified outside permanent equity
• Subsequent treatment depends upon whether
  securities are currently redeemable, or probable
  of becoming currently redeemable in the future
• Probability assessment should NOT consider
  likelihood that other options (such as a
  conversion option) might be exercised first

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Convertible Debt Warrants

• Common area of accounting mistakes as guidance is
  very complex
• FAS 133, EITF Issues 00-19, 98-5, 00-27
• Companies often focus on beneficial conversion
  feature issues and overlook the need to evaluate
  the instrument for embedded derivatives under
  Statement 133

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Is Convertible Debt Conventional?

• Conventional is defined in 00-19 and 05-2
• The holder may realize the value of the
  conversion option only by exercising the option
  and receiving the entire proceeds in a fixed
  number of shares, or the equivalent amount of
  cash (at the discretion of the issuer)
• If conventional, conversion right generally is
  not separated from the debt instrument
• Might have beneficial conversion feature
• Might also have other embedded derivatives
• If not conventional, must analyze conversion
  right under paragraphs 12-33 of EITF 00-19

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Registration Rights

• Often requires issuer to use best efforts to
  register underlying shares within a certain
  timeframe
• If provisions are not met, the company is
  typically required to pay liquidating damages
• If liquidating damages are not limited to the
  difference between the fair value of a registered
  share and an unregistered share, security would
  not be classified as equity

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Sufficient Authorized and Unissued Shares

• Another requirement for equity classification is
  that the company have sufficient authorized and
  unissued shares to settle the conversion option
• Must consider ALL commitments that might require
  issuance of stock
• If the number of shares to be issued is not
  capped, the company cannot conclude that
  sufficient authorized and unissued shares exist
• Equity classification is not appropriate

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Implicit Variable Interests

• FSP FIN 46(R)-5 provides guidance for determining
  when activities around the entity would cause a
  reporting enterprise to have a variable interest
• Driven by facts and circumstances, but the
  following questions should be considered
• Was the arrangement entered into in contemplation
  of the entitys formation?
• Was the arrangement entered into
  contemporaneously with the issuance of a variable
  interest?
• Why was the arrangement entered into with a
  variable interest holder instead of with the
  entity?
• Did the arrangement reference specified assets of
  the VIE?